Falling Home Prices Keep Buyers on the Sidelines

At the end of 2010, many were predicting a steady rise in home-buying activity through 2011. That has yet to happen. In fact, purchase applications were down 0.7 percent in the most recent survey by the Mortgage Bankers Association. For the first three months of 2011, the U.S. real estate market has been similar to 2010. Slow.

But what gives? Home prices are the lowest they’ve been in years. Mortgage rates are still hovering below 5% (averaging 4.76% last week). Even the job market is starting to look up.

So why aren’t more people buying homes these days? In a word, depreciation.

Would-be home buyers are seeing a continuation of home-price declines across the country, and they’re sitting on the bench for now. They’re waiting for the dust to settle. Buyers are not convinced the market has hit bottom.

According to the Federal Housing Finance Agency, U.S. home prices fell 0.3% in January. That’s not a huge drop, obviously. But the key word here is “steady.” There appears to be another steady decline in home values, for most parts of the country. Prices dropped in December too.

Home Prices Falling Further in 2011?

Many analysts are predicting another drop for the February-to-March time frame. MacroMarkets surveyed 111 economists and housing analysts about their expectations for home prices. Most don’t expect the U.S. housing market to hit bottom until 2012. On average, the survey respondents expected home prices to fall another 1.4% in 2011.

Compare that to this time last year, when the panelists predicted home prices to rise by 1.3% in 2011. In terms of market expectations, they are kicking the can down the road.

According to Robert Shiller, co-founder of MacroMarkets and co-creator of the S&P/Case-Shiller report: “The sentiment among our expert panel regarding the U.S. housing market outlook continues to deteriorate.”

The Effect On Buyer Confidence

Are home buyers getting the word? Are they reading the same housing reports I read every day? Apparently, many of them are. Or else they’re getting second-hand accounts from the media. Regardless of where they get their information, home buyers are certainly aware of what’s happening in the housing world. We receive dozens of email questions from readers every month, and the latest Q&A trend is all about home prices.

These buyers all want to know the same thing: When will prices stop falling in my area? Where is the bottom? When does it make sense to buy a home?

Last week, the question came from a would-be home buyer in the San Francisco Bay Area. The couple were planning to move so the husband could be closer to work. But they were uncertain about the home price situation. This is the question of the year for buyers: Is the market going to hit bottom this year, or will it keep falling?

Obviously, no one can predict the future of home prices. [See the revised prediction among leading economists above.] But we can look at recent trends to get a slightly clearer picture. That is what I advised the Bay Area buyers to do. I pointed out that prices in their market had fallen for the last couple of months, and that the trend could likely continue in the coming months.

A Good Investment Doesn’t Always Need a “Bottom”

Home buyers are keeping an eye on home prices, waiting for the right time to buy a house. But how do you define the “right time” to buy? First of all, it doesn’t have to be when the market bottoms. And it has everything to do with your long-term plans. Buyers should be asking two key questions:

Will this house be a good investment for me, for most of the time I live in it?

Will I be happy in this house?

These days, it seems a lot of people are forgetting about the second question. A house is an investment, but it’s also a home. As for the first question, buyers should avoid the kind of “bottom fixation” that can lead to financial tunnel-vision. Sure, it would be nice to buy at the absolute bottom of a market, when there’s nothing but sunny days of appreciation ahead. But it’s not necessary.

Consider the following example:

John and Jane buy a house in May of 2011. From June to November, home prices in their area drop by one percent. The market value of their home goes from $350,000 to $346,500. But they still have positive equity because they made a down payment of 10%. During the next five years, home prices in their city appreciate by 3.5%. So their property value rises to around $359,000. That’s a gain of $9,000 over the original purchase price, in spite of a slight dip during the latter part of 2011. So they’ve actually gained equity in a relatively short time. The home has turned out to be a good investment. And if the couple are happy in the home, they’ve got a check in that box as well.

Want to use this graphic? Feel free. Please link back to the source.

Buying at the bottom of the market would be nice. It’s just not as necessary as many people think. If all the signs point to a stronger local market in the coming years, then it could be a good time to buy. The diagram above shows three of the most important factors when making a home-buying decision.

Home buyers should put on their research hats to learn about their local markets. Don’t trust what the real estate agents tell you (they’re biased toward a positive outlook). Don’t trust what “some guy with a blog” tells you. Do your own research. Be your own advocate.

Disclaimer: This story contains forward-looking statements about home prices in the United States. These statements should not be taken as matters of fact. They are projections based on current market conditions. Every real estate market is different, so this commentary will not apply to all areas. We encourage you to research home prices and real estate trends in your local market, before making any buying decisions.